Many believe that the behavior of economic and financial systems should be viewed like almost any other system of nature in that they can be tracked to follow relatively predictable mathematical patterns which can then be exploited by those who understand these natural phenomena. The problems historically with this approach is (1) one must actually identify and understand such natural patterns, and (2) once identified, the data of such patterns must be effectively marshalled such that an interested user (such as a trader in securities such as stocks, bonds, etc. or in commodities) can use the data with relative ease and effectiveness.
In the financial markets, many in the industry believe that trends in prices are more or less arrested or reversed at what are called support and resistance levels, which are to some degree predictable from the past behavior of the price series. Support and resistance levels (also sometimes called support and resistance lines) are a concept that virtually all traders are familiar with. See, for example, Osler, Carol, “Support for Resistance: Technical Analysis and Intraday Exchange Rates”, Federal Reserve Bank of New York Economic Policy Review 6 (2), July 2000, pp 53-68 (“ . . . [T]he vast majority of the daily technical reports include “support” and “resistance” levels.”). Some support and resistance levels are a moving average, while others are based on previous high and low prices (e.g., the previous trading day's opening and closing prices), or derivations of high and low prices. A brief explanation of support and resistance levels follows below.
“Support levels” are prices that become more difficult for the current price to go below as trading patterns develop above them, further defining the particular price or area in price as time goes by. Traders want to identify these areas of price as soon as possible. The obvious goal is to essentially identify the predicted “floor” for the price of a traded security or commodity, relative to a current trading price, such that the trader knows when a “buy” order should be made. To put it another way, an attempt is made to buy at the lowest possible price without risking that the trader waits too long until after the price is already consistently trending significantly back up above the support level.
Conversely, “resistance levels” are the opposite of “support levels” in that it can be observed that a given starting price of a security can approach a price level which almost acts as a limit and is very difficult to go above. The obvious goal associated with identifying a given resistance level is to attempt to identify the point at which a trader should consider selling a given security or commodity in order to avoid a subsequent downward pricing trend (that is, “sell high”).
It should be noted that both support and resistance levels relative to a given starting price are merely statistical guidelines, but are hardly hard limits on prices. When effectively identified, they can be tools for traders to mitigate risks. However, a price can nevertheless “break through” and go below a given support level, at which point the breached support level now becomes the new resistance level, and the price of the security or commodity in question will tend to continue to fall until a new support level is encountered. Likewise, a price can “break through” and exceed a resistance level, at which point the breach resistance level now becomes the new support level, and the price of the security or commodity will tend to continue to rise until a new resistance level is encountered.
Over the years, many have attempted to identify a valid pricing pattern that would facilitate the development of a system to provide useful “magic numbers” to traders and other consumers such that consistently prudent trading decisions are made. That is, what is desired is a system that can provide a prediction success rate of significantly over 50%. One measure of success is to track pricing levels for a given security or commodity and observe the “bounce frequency” at the prescribed support and resistance levels. Further, it is desired to have success rates that exceed those of systems that arbitrarily prescribe support and resistance levels, which Osler measured at around 56.2% (see Osler at 61).
Among those attempting to identify a pattern to pricing trends in support of a system to provide traders with useful support and resistance pricing levels relative to a trader-input pricing starting point, was W. D. Gann, a 20th century market theorist, whose theories and economic philosophies incorporated “Gann angles” as he discussed in “The Basis of My Forecasting Method”, published in 1935, which included methodologies that incorporated geometry, ancient mathematics, and even astrology. Gann devised a spiraling price chart based on his observation of number patterns that divided price into proportionate parts. Furthermore, Gann applied geometric squares to equate equal moves in time to equal moves in price. Opinions over the value and relevance of Gann's work are sharply divided.
Robert W. Colby, CMT, also wrote about some of Gann's work, including Gann's “Square of Nine” (see Colby, Robert W., “The Encyclopedia of Technical Market Indicators”, 2nd Ed., McGraw-Hill, ISBN 0-07-012057-9, pp 287-288). Gann's “Square of Nine” attempts to relate a number of natural cycles, relationships, and structures to pricing behaviors, including those that appear in the Great Pyramid, Fibonacci spirals, various harmonic frequencies, the celestial and acoustic vibrations of Pythagoras, Galileo's Theorem of Equivalence and his concept of the solar system, and the equal tempered twelve-tone musical scale of Leonard Euler. Once again, the effectiveness of Gann's methods have been questioned within the industry.
Modern-day attempts to build on and improve on Gann's work include the work of T. H. Murrey, who developed a system called “Murrey Math”. Murrey's solution, like Gann's, tries to employ various unorthodox techniques (e.g., numerology, alleged “hidden” values from Biblical scriptures), as well as seemingly arbitrary basis values such as birthdates or Mayan calendar dates. Consequently, the effectiveness of the software tools created by Murrey to implement his theories remains in question.
Another modern-day attempt to build upon Gann's use of Fibonacci sequences is dubbed “DanielCode”, developed by John Needham. Once again, the goal of the DanielCode system seems to be to try and identify sets of support and resistance levels about a user-prescribed initial price point. However, this system relies on the alleged significance of supposedly historically and/or biblically significant numbers.
A more reliable and effective system for supplying technical indicators to aid in buy and sell decisions for securities and/or commodities is perpetually wished for in the trading industry. Such traders include:                The “Fib” Confluence Trader, who uses Fibonocci extensions and projections based on previous important highs and lows (ranges) and their proportional key ratios (e.g., 0.382, 0.500, 0.618, 1.0, 1.618, 2.0, 2.236, etc.) in order to identify areas where there is a confluence of possible future levels that hopefully will help determine where turnarounds or possible target areas may occur.        The “Pattern” Trader, who uses pattern recognition to determine when to enter or exit a trade. Patterns can be any of various configurations of previous price behaviors that seem to predict a likelihood of repeating the pattern once again. Among such patterns are “Cup and Handle”, “Double Tops”, “Rising Triple Tops”, “Flag Patterns”, “Parabolic”, “Andrew Pitchforks”, and “Trend” lines.        The “Elliot Wave” Trader, who counts the progression of waves in the market to determine where likely turnarounds are to occur, based on wave theory.        The “Trend Follower”, who espouses the motto “the trend is your friend” and waits for a pullback when the market is trending higher to make his entry and do the opposite when the trend is down.        The “Momentum Change” Trader uses indicators such as Moving Average Convergence and Divergence (MACD), where the momentum value indicator itself is based on a previous specific time period. Other various indicators are used, many of which are proprietary, that detect when a change in price momentum is occurring. As the previous high-momentum move in price wanes, the trader prepares for the inevitable change in direction that will occur.        Traders of “Esoteric Methods”, which include many of the prior-art examples discussed above, use horoscopes, planet alignments, moon cycles, Biblical references, Murrey Math, Gann harmonic Wheel Numbers, and such.        The “Bond and Currency” Trader, as discussed in Olser, supra.        